History repeats itself. Although it does not repeat exactly in the same way, it rhymes. Consider this, exactly one year ago, on March 16th, Cyprus reached the newswires globally with the announcement of its bank bail-ins.
One year later, the geopolitical escalation between Ukraine and Russia is front stage. Just moments ago, the long awaited referendum in Crimea resulted in an overwhelming 95% of votes to join Russia, according to Reuters. The Western world, even before the closing of the referendum, has officially stated that it denies the results.
Think about this. Crimea has 2 million inhabitants, a GDP of $4.3 billion, an average monthly salary of $290, a budget deficit $1 billion. Its GDP is 0,02% of the US GDP. Yet, the US government, along with “its friends and allies”, feels the need to intervene in Putin’s backyard. Why?
Motives of the West become much more clear when looking below the surface, in this case literally. It appears that Crimea has a capacity of 7 million tons of oil production per year. Moreover, ExxonMobil and Royal Dutch Shell have closed a deal (although currently on hold) worth $1 billion. As far as Ukraine is concerned, it is a central hub of energy supply to the West, in particular gas.
Now there is nothing new to this. All geopolitical tensions of the last decades were centered around oil, gas or other commodities. Think of Iraq two decades ago, Syria very recently, and a dozens of other examples in between. However, there are important reasons why “this time could really be different.”
Next to the tensions in Russia, there are signs that the Chinese credit bubble, the biggest credit bubble in history, is cracking. Chinese bank assets expressed in US Dollars currently exceed 25 trillion, while US bank assets are close to 14 trillion USD. Chinese credit doubled since 2009. The most concerning news, however, is under the hood. Zerohedge cited Bank of America, when they discovered that one of the large trusts (CITIC) “tried to auction the collateral but failed to do so because the developer has sold the collateral and also mortgaged it to a few other lenders.”
The fundamental issue here is that an economic crisis, which seems developing, could be very different this time. The effect could really be dramatic. The reason why “this time is different” is directly related to the worsening debt crisis, which is inherently linked to the currency wars. The US is playing a key role here. Why? During all previous escalations, the US, with its global dominance, was in a better economic shape than it is today. And so was the rest of the world. Think about these global facts and figures:
- Global debt in the financial system is at historic highs. It recently surpassed $100 trillion, as reported by Bloomberg based on BIS data.
- US government debt alone has surged to $12 trillion up from $4.5 trillion at the end of 2007.
- The interest rates on government debt, especially in the US with a zero interest rate policy, is at 5,000 year lows.
- Global derivatives have a notional value of around $700 trillion (latest official BIS data from mid 2013), the highest point historically.
What this means in plain simple terms is that the financial system is extremely leveraged, highly sensible to an external shock. All major economies and, hence, the whole world, is inherently vulnerable. Unfortunately, the first signs of cracks are there, as evidenced by several facts in the last two weeks.
First, Friday’s reported data about US Treasuries from foreigners held by the Fed, has shown a drop of $104.5 billion. Zerohedge notes: “This was the biggest drop of Treasurys held by the Fed on record, i.e., foreigners were really busy selling. This brings the total Treasury holdings in custody at the Fed to levels not seen since December 2012, a period during which the Fed alone has monetized well over $1 trillion in US paper.” The following chart says it all.
Why is this important? US Treasuries are the backbone of the world monetary system, at least as long as the US dollar is the world reserve currency. Think about this: China held $1.269 trillion of US Treasuries and Japan $1.183 trillion at the end of December, while Russia held $138.6 billion. After the US sent out warnings to Russia, China openly chose the side of Russia. Below the surface, however, “someone” sent a very strong signal to the US, and, by doing so, to the world, by withdrawing record amounts of US Treasuries. This is economic warfare at a level not seen to date, because of the current extremes in the monetary system.
Second, in the context of international currencies, Russia is likely to engage with China more actively in bilateral trade with the ultimate goal to transact in their own currencies, bypassing the US Dollar. It is not unthinkable that they will use gold.
As Ambrose Evans noted this week, the latest financial ructions go beyond Russia, they reek of stress in the international system. “Countries are intervening all over the place to defend their currencies, which means they are tightening. Their central banks built up huge war chests of reserves for a rainy day, and now it is raining,” said the currency chief at HSBC.
One of the biggest concerns for the US in particular would arise when Russia, backed by China, will start trading oil for gold, as we wrote in “Russia Touches U.S. Achilles Heel: Petrogold instead of Petrodollar.” Similar attempts of other countries in the past were not very effective. Think of Iraq or Turkey recently. But with major countries like Russia or China front stage, this has the potential to truly disrupt the US Dollar, and, hence, the world monetary system.
Note that the US Dollar has been a safe haven currency in the last years and even decades. Political tensions and wars have resulted in a flight to the dollar. Not so this time. In fact, since the tensions in Ukraine started a couple of weeks ago, the US Dollar index has turned down.
Now what is the key take-away of all this? In our view, the current situation highlights three fundamental trends in the big picture.
First, central bank control is an illusion. As hard as central banks are trying to achieve some specific goals, think of zero interest rates, inflation or GDP growth, it is ultimately the market that will determine what will happen. Look at the recent evolutions as described above. Even the most powerful countries on this planet cannot control market forces. Their power looks convincing in “normal market circumstances,” but the truth is they are powerless in times of stress in the market.
In that context, we think it is appropriate to quote John Williams, researcher at Shadowstats.com, when he recently explained what would happen if there was a massive dollar dumping globally. “It would be disastrous for our markets. All those excess dollars coming in, with bonds being sold, interest rates would spike. The stock market would sell off and we would see inflation. To prevent that and try and keep things stable, the Fed would tend to buy up those Treasuries. It would intervene wherever it could to stabilize the circumstance.”
Second, paper assets are in a secular decline. It really does not matter that US and some European equities are at trading at all-time highs. They are doomed to fail till the bear cycle is over. Why? Because the inherent weakness of our financial system, with the US Dollar vulnerability at its heart, built on fiat.
The fact that Russia’s stock market is being hit recently seems not to be of the highest importance for Putin. We agree with Zerohedge when they wrote that “for Putin it is orders of magnitude more important to have the price of commodities, primarily crude and gas, high than seeing the illusion of paper wealth, aka stocks, hitting all time highs.”
It really is no coincidence that most countries, including Russia, China, and the likes, have been adding to their gold reserves for several years. This brings up the third long term trend: gold is in a secular uptrend. Yes, the gold price sold off in 2013. No, the price of gold is not the only aspect that matters. What is far more important is the protection one gets from physical gold.
Gold’s protection serves individuals as well as countries. The “Golden Rule” will continue to be relevant to countries: he who holds the gold rules. Quoting Michael Noonan: “The transition of physical gold from West to East is disrupting the elites domination of the entire financial world. The East has been saying “Enough is enough.” In our view, that is reflected in Eastern physical gold accumulation.
To individuals, what matters is that physical gold is immune to counterparty risk. And this, ladies and gentlemen, we believe is the key take-away from the ongoing economic and financial turmoil. All those dollars, Treasuries, stocks, derivatives, e.a., running a risk to become the object of the new economic warfare, in the context of extreme leverage and excess liquidity, has one and only one antidote: unencumbered ownership of physical gold and silver.
Precious metals in physical form, outside the banking system, are the antidote against what is happening in the world today. Protect yourself, there is still some time to do it (before it is too late). Here is one excellent way to protect your savings with physical gold and silver outside the banking system.